Mixed Bag at Time Warner

Time Warner Inc. kicked off the fourth-quarter earnings season last week with mixed results, reversing the heavy losses of 2002 but showing less-than-stellar growth in some key segments, including cable.

Net income for the quarter was $638 million (14 cents per share), versus a $44.9-billion loss ($10.04 per share) in the same period in 2002, attributed mainly to a huge write-down in the value of America Online.

Analysts seemed encouraged, but disappointed in sluggish growth at the cable operations and networks divisions.

Overall, Time Warner said revenue rose 6%, to $10.9 billion, and cash flow (operating income before depreciation and amortization) declined 2%, to $2.4 billion.

Those were in line with most analysts' expectations, but the mix many considered to be surprising.

CABLE DIDN'T LEAD

For the past three quarters, results have been driven by strong growth at Time Warner's cable operations and networks, while filmed entertainment (mainly its Warner Bros. movie studio) was usually a drag.

Fulcrum Global Partners analyst Richard Greenfield said the networks' results were even weaker than they seemed. He said that on a reported basis, the network division declined 1.5%, driven by a falloff in advertising sales at The WB broadcast network and the timing of planned programming investments and related marketing expenses at Turner Broadcasting System Inc.'s networks.

But Greenfield added in a note that within those results was a $45 million benefit at Home Box Office Inc., from an accounting change in accruing programming costs. Because many of HBO's original programs are available for syndication, HBO must now defer a portion of initial programming costs to match against future syndication revenue. Without that benefit, the networks' cash flow would have been down about 16%, Greenfield wrote.

BULLISH ON '04

Still, Greenfield was encouraged by guidance for 2004 — cash-flow growth for the year is expected to be in the high single digits to low teens — and said Time Warner should comfortably reach that goal given the relative easy comparisons to 2003.

According to Greenfield, Time Warner had nearly $250 million in one-time costs in 2003, including $109 million in restructuring charges, $45 million in pension costs and $72 million in marketing costs from the recently sold Time-Life Inc. direct-marketing unit.

Greenfield estimated that to reach the midpoint of its guidance (10%), actual cash-flow growth need only be about 7% for the year.

Entertainment and networks group chairman Jeff Bewkes said on a conference call with analysts that the fourth quarter was traditionally weak for the programming unit, because that's when a large amount of high-cost programming hits the schedule.

As examples, Bewkes pointed to HBO's acclaimed miniseries Angels in America and the 15 theatrical movies run by Turner Network Television and TBS Superstation (as opposed to five the previous year).

Bewkes said the good news for 2004 is that with syndication deals for HBO's Sex and the City and other shows hopefully on the way, the content division has developed a new revenue stream.

BASIC SUBS DIP

At the cable operations, basic subscribers dipped slightly — about 9,000 customers — to end the year at 10.919 million.

Growth in new services was strong: Time Warner finished the year with 360,000 digital video recorder customers (it expects to double that by the end of 2004), 950,000 subscription video-on-demand subscribers and 200,000 HDTV customers.

While digital and high-speed data growth is slowing, UBS Warburg cable analyst Aryeh Bourkoff said rising numbers of DVR and SVOD customers should help stem digital churn. "The company is spending money to make money in this segment," Bourkoff wrote in a note.

Time Warner's share price slipped 85 cents on Jan. 28, to $17.96, in an overall down day for the market. It fell another 21 cents on Jan. 29.

Time Warner chairman and CEO Richard Parsons told analysts fourth-quarter results were in line with expectations, and that Time Warner had successfully transitioned from what was a "reset year" (2003) to one where sustainable growth will be the mantra.

Parsons added on the conference call that with Time Warner's debt-reduction plan completed about a year early — net debt will be $20.1 billion after it receives the $2.6 billion from the sale of its Warner Music Group in the first quarter — it can focus on growing internally and externally.

"Our strategy and vision is using our capital in high-growth, high-return opportunities," Parsons said. "We're now in a position to look outside our company for promising investments, but when we evaluate our alternatives we'll employ the same focus and same discipline we used in our debt reduction program and we will be patient."

VOIP EMPHASIS

Parsons also pointed to internal uses of that capital, citing Time Warner Cable's accelerated rollout of voice-over-Internet protocol as a prime example.

Time Warner has already rolled out VoIP service in Portland, Maine; Raleigh and Charlotte, N.C.; and Kansas City, and plans to make it available throughout its footprint by the end of 2004.

Parsons said the acceleration of the VoIP rollout is in part an answer to satellite competition.

"There is no question that satellite is a real competitor and the competition is getting tougher," Parsons said. "While across the footprint, Time Warner Cable has probably done better than other cable companies in fending off satellite, the addition of the voice leg is going to be a major asset in making the cable service stickier and actually giving us an offensive weapon to compete more aggressively and more effectively going forward."